Is the U.S. heading into a recession? Opinions are divided but, on one level, it doesn’t matter. It’s always a good time for small businesses to prepare for a downturn in the economy.
The most important thing any small business should do toward that end is to take control of its finances. Ideally, this should happen well before a downturn looms. If not, however, there are still things small business owners can do to protect and preserve their enterprises.
Explore Your Financing Options
First, consider the easiest financing option: What’s the credit limit on your corporate credit card, and is it sufficient? Would it be possible to get this maximum raised? Prepare to answer questions from your lender if you do start using more credit than usual. They need to do their due diligence to protect themselves from excessive risk.
Other financing options may also be available. One of these is a bridge loan. Various lenders, including mezzanine debt, SBIC funds and direct lenders, can provide bridge financing. In these cases, investors often receive a small ownership stake in the company or an option to buy equity in the future. While the interest on this type of debt tends to be high, these expenses are partially offset by their tax-deductible character.
Another option is an equity injection. There are several minority equity investors that can provide bridge financing and growth financing. These investors tend to be more active in supporting the business and look for an exit on the horizon.
When investigating external sources of financing, however, keep in mind that these can dry up during a recession. Banks and other financial institutions can tighten their criteria or suddenly change their requirements. Interest rates for loans may also increase.
That’s why it’s always important to have substantial cash reserves on hand. For less-established businesses with fewer options for financing, I recommend having six months’ worth of funds available. For those that are more established and have more options for financing, having three months’ worth of cash could be adequate.
Finally, consider what assets your business might be able to sell or leverage if the situation becomes dire. Do you own real estate? Do you have aged inventory? Would it be possible to rent or lease any of your equipment or spaces to others?
Preserve Your Cash Flow
To preserve your business’s cash flow, you must first understand your cash flow. You already know you need to track your expenses and income, so chances are likely that you’re already doing this. But have you developed a reliable 13-week forecast of your cash flow? Can you predict your company’s cash flow one to two weeks in advance with 95% accuracy? If not, now’s the time to develop this capacity — not when a recession has already begun.
Having an accurate idea of your company’s cash flow is necessary in order to understand how long your current cash will probably last. This is called your company’s runway.
When predicting your cash flow, be aware that some declines in income are normal during a recession. As financial pain spreads throughout the economy, for instance, it is common for customers to start paying late or have trouble paying. Suppliers can also struggle to meet deadlines, leading to delays in your incoming shipments.
When it comes to preserving your cash flow, therefore, my advice is to be flexible and adapt. Strong customer relationships are necessary to pull through difficult times, so if one is struggling to pay, try to work with them and find temporary solutions. This might even require you to make concessions, but it’s better to keep a customer than to lose one.
Similarly, keep investing in marketing even during times of recession. These efforts keep business coming through your door, so it’s a mistake to deprioritize them. However, make sure to avoid pouring desperately needed cash into ineffective campaigns by tracking the effectiveness of these efforts.
Restructuring Your business: Plan and Implementation
No small business owner likes the thought of making major changes to their business, but, in times of recession, these can sometimes be required.
The time to think about possible restructuring is when you can be the least emotional about these decisions and have the sharpest higher-order thinking skills. Namely, the time to think about possible restructuring is before a recession, not during one.
When developing your restructuring plan, don’t forget to consider all possible scenarios for the future, not just the worst-case scenario. For instance, how can your business adapt if the economy rebounds quickly?
Furthermore, make sure to specify benchmarks in your plan for when certain restructuring methods should be put into effect. When it comes to implementing the restructuring plan, the most important thing is to honor those benchmarks. Otherwise, even the smartest entrepreneur can go into denial and put off the necessary actions until too late. This places the business at risk of going into a degenerative spiral from which recovery may not be possible.
Finally, remember that help is always available. Indeed, if you find yourself experiencing difficult emotions while contemplating how to prepare your small business for a recession, the answer might be to gain an outside perspective. Experienced professionals can bring a dispassionate viewpoint and expert knowledge on how best to prepare your business to weather a recession.
Jay Jung is the founder and managing partner at Embarc Advisors. During his 20 years of experience in corporate finance, he has served as an investment banker at Goldman Sachs and a consultant at McKinsey & Company. He currently works with startups and middle-market companies on M&A, capital raise, and strategic CFO services. He has an MBA from the Wharton Business School of the University of Pennsylvania.
